Citing Keynesian theory and weak economics numbers, he warned about “the austerity doctrine that has dominated elite policy discussion” and says that the British government made a mistake when it decided to “slash spending.”

In support of the New York Times columnist, another blogger commented on the “sharp retrenchment in public spending” in the U.K. And a Bloomberg editorial also supported Krugman’s position, stating that recent events “undermine the conservative idea that slashing government spending will somehow bring about a confidence-driven economic boom.”

There’s only one small, itsy-bitsy, teeny-weeny problem with all of these statements. They’re based on a falsehood. Government spending in the United Kingdom has not been slashed. It hasn’t been retrenched. It hasn’t even been cut.

I first made this point back in 2010. And I also noted that year that the supposedly conservative Chancellor of the Exchequer advocated a big increase in the value-added tax was good since it would generate “13 billion pounds we don’t have to find from extra spending cuts.”

To be fair, spending hasn’t been growing as fast in the past couple of years as it did last decade. According to European Union data, government spending in the United Kingdom grew by an average of 7.6 percent each year between 2000-2008, so the recent annual increases of 2 percent-4 percent may seem frugal by comparison.

Not only haven’t there been any spending cuts in recent years, but it also appears that there won’t be any in future years. The Centre for Policy Studies just put out a report comparing “austerity” in the United Kingdom today with the fiscal discipline that took place in Canada during the 1990s.

The Canada of 1994 in many ways resembled the Greece of today. …Spending was to fall 8.8% over two years. Large cuts in transportation, industry, regional development, and scientific support were made. The size of the federal government was to decline from 16.2% of GDP in 1994 to 13.1% in 1996. Public-sector employment was to fall by 14%. The new discipline paid off quickly. Federal government spending as a share of the economy fell more rapidly than planned. Provincial government spending also decreased significantly from 25% of GDP to 20%. …Ottawa offered a historic deal to the provincial governments: unprecedented freedom to make their own welfare policies. This was localism in action – and it unleashed a wave of fruitful experimentation and innovation in the provinces, while spending was cut at the national level. The results were stunning. Large numbers of Canadians, previously trapped in poorly designed benefit programmes, returned to the workforce. By 2000, the number of welfare beneficiaries in Canada had declined by more than a million people, from 10.7% in 1994 of the population to 5.1% in 2009. …Cuts ranged from 5% to 65% of departmental budgets and included cuts to health budgets. In the end, programme spending (everything except interest payments on the debt) fell by 9.7% in nominal terms (or C$11.9 billion) between 1994-95 and 1996-97.

So what were the results of this fiscal discipline? Let’s go back to the report.

Fast-forward again to 2007, and Canada seemed to be back on track. The country’s economy grew at an average rate of 3.3% between 1997 and 2007, the highest average growth among the G-7 countries, including the US. Canada’s job-creation record was nothing short of stellar. From 1997 to 2007, Canada’s average employment growth was 2.1%, doubling that of the US and exceeding employment growth in all other G-7 countries. Perhaps most importantly for future economic prosperity, during the same period Canada outperformed the G-7 average almost every year on business investment. …Canada weathered the recent recession better than its G-7 partners. … None of Canada’s major financial institutions had to be bailed out

And this also was a period of tax cuts.

…coupled with stronger economic performance than expected, meant Ottawa could then cut taxes, including personal and corporate income taxes, capital gains taxes, and the corporate capital tax. In this period:

Corporate Income Tax (federal) was reduced from 28% to 21% with further cuts planned;

Capital Gains Tax were reduced to 14.5%;

Personal Income Tax rates were finally indexed to inflation;

Federal capital taxes were abolished.

It certainly seems that genuine fiscal restraint worked in Canada.

To be fair, though, Krugman isn’t arguing against small government in his column. He’s arguing for short-run Keynesian stimulus policy. And it’s possible to be in favor of more spending in the short run and smaller government in the long run.

Moreover, I’m not arguing that genuine spending cuts are immediately expansionary, as some research has indicated. I’m sure that happens in some cases, but it’s not a hard and fast rule.

And I imagine that there are cases where the economy does hit a short-run speed bump when the public sector is pruned. Simply stated, there will be transitional costs when the burden of public spending is reduced. Only in economics textbooks is it possible to seamlessly and immediately reallocate resources.

My argument is that the short-term impact of spending restraint – whether positive or negative – is trivial compared to the long-run benefits of better fiscal policy. A small public sector means labor and capital get used more productively, and it presumably also allows a less punitive tax system.

This video has more information about Canada’s fiscal policy success, along with data about similar episodes of genuine austerity (properly defined) in Ireland, Slovakia, and New Zealand.

40 Responses

One of the things that’s genuinely annoying about the Krugman’s of the world, is that on some level, I don’t give a rat’s ass if government spending is stimulative or not. I want my government to live within it’s budget ALWAYS. I don’t need a bunch of idiots in Washington trying to micromanage the economy. So, you know, economic arguments aside, like probably most sensible Americans, I want the government to manage it’s finances like I manage my own. Not that complicated. Academic voodoo? I could give a shit.

[…] fair, Romney’s statement doesn’t automatically make him a big-spending Keynesian. Even I have written that, in the short run, “there will be transitional costs when the burden of public spending […]

[…] be fair, Romney’s statement doesn’t automatically make him a big-spending Keynesian. Even I have written that, in the short run, “there will be transitional costs when the burden of public spending is […]

[…] For instance, what’s the definition of austerity? Is it budget cuts, higher taxes, or both? Why are people saying the United Kingdom is practicing austerity, when the burden of government spending is going […]

[…] not go with a big program of government spending, and they did better than the United States. The same is true about Canada. But the real success story is the Baltic nations. They imposed real spending restraint, not the […]

[…] not go with a big program of government spending, and they did better than the United States. The same is true about Canada. But the real success story is the Baltic nations. They imposed real spending restraint, not the […]

[…] theory, but that doesn’t mean it is easy or painless to shrink the burden of government. As I wrote earlier this year, “…the economy does hit a short-run speed bump when the public sector is pruned. Simply […]

[…] already commented on good Canadian fiscal policy (including a much-needed lesson for Paul Krugman), and I’ve also praised our northern neighbors for privatizing their air traffic control system […]

[…] not go with a big program of government spending, and they did better than the United States. The same is true about Canada. But the real success story is the Baltic nations. They imposed real spending restraint, not the […]

[…] I wouldn’t even complain if they claimed that a sequester is painful because of short-term economic dislocation and transition costs. Heck, I even said that might be a legitimate excuse when Mitt Romney said something that sounded […]

[…] already commented on good Canadian fiscal policy (including a much-needed lesson for Paul Krugman), and I’ve also praised our northern neighbors for privatizing their air traffic control system […]

[…] was nonsense. There have not been any genuine budget cuts in the United Kingdom. Heck, just compare what’s happening today in the United Kingdom and what happened in Canada in the 1990s to see the difference between gimmickry and real fiscal […]

[…] of the interview was to explain that government spending hasn’t been cut in Europe, with the United Kingdom being a poster child for bad policy (you won’t be surprised that Paul Krugman hasn’t bothered to look at the actual […]

[…] of the interview was to explain that government spending hasn’t been cut in Europe, with the United Kingdom being a poster child for bad policy (you won’t be surprised thatPaul Krugman hasn’t bothered to look at the actual […]

[…] was nonsense. There have not been any genuine budget cuts in the United Kingdom. Heck, just compare what’s happening today in the United Kingdom and what happened in Canada in the 1990s to see the difference between gimmickry and real fiscal […]

[…] don’t get instantaneously reallocated when the burden of government spending is reduced. So I’ve always been willing to admit there could be a few speed bumps as some additional labor and capital get absorbed into the […]

[…] And if you somehow think that we can’t learn any lessons from small Asian economies, look at Canada, which has significantly boosted its jobs market with pro-growth reforms, or Switzerland, which […]

[…] markets that enjoy strong and sustained growth with very low levels of joblessness. …look at Canada, which has significantly boosted its jobs market with pro-growth reforms, or Switzerland, which has […]

[…] markets that enjoy strong and sustained growth with very low levels of joblessness. …look at Canada, which has significantly boosted its jobs market with pro-growth reforms, or Switzerland, which has […]

[…] markets that enjoy strong and sustained growth with very low levels of joblessness. …look at Canada, which has significantly boosted its jobs market with pro-growth reforms, or Switzerland, which […]

[…] And if you somehow think that we can’t learn any lessons from small Asian economies, look at Canada, which has significantly boosted its jobs market with pro-growth reforms, or Switzerland, which […]

[…] P.S. In an example of sloppy/biased journalism, the U.S. News article states that “The show has struck a strong chord in a nation…still reeling from its most brutal austerity measures in a generation, with basic public services trimmed drastically.” Why is that passage biased and/or sloppy? Well, because as I had to explain to Paul Krugman, there hasn’t been any genuine austerity in the United Kingdom. […]

[…] of the interview was to explain that government spending hasn’t been cut in Europe, with the United Kingdom being a poster child for bad policy (you won’t be surprised thatPaul Krugman hasn’t bothered to look at the actual […]

[…] don’t get instantaneously reallocated when the burden of government spending is reduced. So I’ve always been willing to admit there could be a few speed bumps as some additional labor and capital get absorbed into the […]